Tag: federal-reserve

In the week just past, the most relevant macro event came in the form of the FOMC decision to cut policy rates by 25 basis points, widely characterized as a “hawkish cut,” accompanied by an unchanged dot plot implying only one additional cut in 2026. However, the market largely discounted the dots, viewing them as stale given all of the uncertainties surrounding the macro narrative over the course of 2026.

While the initial communication was in keeping with this notion that this week’s cut was something of an insurance measure, what we heard from Powell was taken far more dovishly by the market as the chair acknowledged that the persistent inflation risks resulting from tariffs have not been as severe as initially feared, and there is still plenty of concern around the state of the labor market, which means that the Fed is going to need to continue normalizing rates. Afterall Powell is still in easing mode.

In the meantime, the Fed surprised the market with an earlier-than-expected activation of its Reserve Management Purchase (RMP) program, effectively hedging liquidity risks that showed up as year-end funding pressures emerged. While expectations around the pace and scope of rate cuts in 2026 have cooled, the Fed delivered a more dovish liquidity package than anticipated by announcing the start of RMPs sooner and at a larger scale. In the first month alone, the Fed committed to buying around $40 billion of short-dated Treasuries under three years and signaled that elevated purchasing levels would persist in the months ahead.

This decision came against a backdrop of volatile Treasury General Account (TGA) balances as the government reopened and a sustained decline in reserve balances—recently slipping below 13 % of commercial bank assets. The recent liquidity stress has been pretty visible in risk assets. Bitcoin, often viewed as a liquidity-driven risk barometer, has broken below key technical levels and exhibited heightened volatility.

Part of liquidity tightness can be traced to strategic balance sheet moves by the notably JPMorgan’s withdrawal of roughly $350 billion from its Federal Reserve deposits to buy Treasuries ahead of expected rate cuts. By redeploying these reserves into government debt, JPMorgan materially reduced system-wide reserves, contributing to tighter money market conditions and higher repo rates before the Fed’s liquidity interventions.

The reserve management purchases at $40 billion a month began on the 12th of December is a clear effort on the part of the Fed to support the bill market. I have to mention, using the Fed’s balance sheet to effectively monetize the deficit has long been a risk. And now that it has come to fruition, the takeaway is it’s not a significant market event. It will be interesting to see whether or not the Fed ultimately needs to increase the size of these purchases, but for the time being, $40 billion did air on the higher side of many estimates. The reserve management purchases also came earlier than the market had anticipated, although it does follow intuitively that the Fed would want to get ahead of any potential year-end funding strains.

In fact, a bigger surprise was the language contained in the implementation note, which included the potential for the Fed to buy securities with maturities up to three years. Now, we did see the upcoming month’s purchase schedule released, and it didn’t include anything other than bills, but in interpreting the steepening of the curve, the fact that two and three year notes may potentially be eligible to be purchased, with obviously an emphasis on flexibility from the Fed’s perspective, certainly contributed to the front-ends out performance in the aftermath of the FOMC. And we’ve already had enough conversations about why this is not a QE program, but nonetheless, the slightly longer maturity profile of what might be purchased in the RMPs represented new information that was not the consensus around what the program would look like going into the Fed.

Taking a step back, and I think it’s important to put the Fed’s decision in the context of what the Treasury Department has been messaging in terms of its issuance intentions. It is notable that one of the market’s biggest concerns from a bond bearish perspective over the course of the summer had been the growing deficit and the forward implications for Treasury issuance. When coupled with the fact that Bessent has clearly communicated the Treasury Department will be primarily utilizing the bill market to fund the deficit, this brings us back to one of our key observations about the interplay between the Treasury Department and the Federal Reserve at the moment. And that is that Bessent has effectively forced the Fed into monetizing the deficit. Now with reserve management purchases, the new norm, it’s not QE, but it is expanding the Fed’s balance sheet, we suspect that it will be difficult for the Fed to back away from those programs for the foreseeable future. And looping this back to the concern that these purchases going potentially all the way out to the three-year sector, as the November refunding statement outlined, while the Treasury Department will be focused on bill issuance over the next fiscal year, come fiscal year 2027, which is November 2026, front-end coupon auction sizes are likely to increase, while 10s, 20s and 30s are more likely to be stable. So in the vein of the Fed monetizing the deficit, policy makers have left open the window to extend that all the way out to the two or three-year sector.

Well, after we spent a lot of time discussing who might it be that would serve as the incremental buyer of treasuries, turns out his name is Kevin Hassett.

And he’ll take two.

Employment is back in the driver’s seat—and inflation has been politely asked to move to the back. This week’s market narrative is a familiar one, but with a few important twists: labor data continues to soften just enough to keep the Fed on an easing path, and inflation remains well-behaved enough to stay out of the headlines. But beyond the policy debate, there’s a quieter development worth flagging, the triangular consolidation in 10s. Yields haven’t broken lower, they haven’t broken higher, and yet the range keeps tightening. Whether this is simply a pause, or the market coiling for something more directional—is the question lurking beneath an otherwise calm surface.

Employment in the driver seat

In the week just past, the economic data cemented expectations for another 25 basis point rate cut when the Fed meets on December 10th. Specifically, ADP for the month of November showed a decline of 32,000 jobs. This largely served to reinforce the notion that we’re in a no hire, no fire labor market at the moment. Consistent with this was an unexpected drop in initial jobless claims to 191,000. We also saw the Revelio Labs print at negative 9,000 for the month of November, and that compares with a downwardly revised negative 16,000 in October. Overall, the theme for the employment proxies has been mixed to weaker. As a result, not only has this firmed up expectations for a Fed rate cut, but it also reduces the probability that Powell strikes a particularly hawkish tone at the press conference.

This dim outlook is reinforced by the continued headlines about large-scale layoffs and of course the employment proxies. It’s also worth noting that within the ADP series, we saw all of the job losses coming from smaller businesses. This is very consistent with the fact that smaller businesses are reportedly suffering more from tariffs and the trade war uncertainty. It will be worth following this series to see if, in fact, those job losses spread to medium and large size firms in the near term.

At some point over the last several weeks, there was lots of doubt that the Fed was going to be bringing rates lower. But between some of the rhetoric from the likes of William and Waller, coming into this week, we saw a return of market pricing to nearly 100 percent odds of another 25 basis point cut in December. Now this leaves the question of how Powell is going to characterize next week’s cut. Is it going to be of the insurance variety or is it simply the latest step on the journey closer to neutral? At this stage and looking out into 2026, it’s that dynamic which is occupying the attention.

Well contained inflation

As the jobs data is in the driver seat for the Fed, market has moved past peak reflationary angst that really characterized the summer months in the treasury market. We have now seen that there was some tariff pass-through, but it has been reasonably well-contained. And perhaps more importantly, the core inflation measures haven’t managed to materially accelerate to the point of becoming troubling for the treasury market or monetary policy makers. For evidence, we looked to 10-year breakevens, which are still sub-225 basis points. Now, when we look at this series over a 25-year history, the average is 207 basis points. So we’re still above the long-run average, but nowhere near the 300 basis point peak seen during the pandemic.

As long as tariff pass-through is spread out over a longer period of time, then we won’t see forward inflation expectations reset to a materially higher plateau. In fact, in considering the year ahead, as the realized inflation data comes in, I expect breakevens to drift lower. When looking at the period between 2014 and the end of 2019, what I see is that breakevens averaged 178 basis points. I am using this as a medium-term target for break-evens once the market is convinced that inflation has in fact, not only not reaccelerated because of the trade war, but also continued to moderate as some of the key distortions created by the pandemic have worked their way out of the real economy.

A Triangular Pause in 10s

With the above backdrop, there is still one important caveat when it comes to the treasury market, and that caveat remains the global sovereign debt complex. As we’ve seen across JGBs, EGBs, and gilts, yields have displayed a notable stickiness to the upside. While U.S. Treasuries have partially decoupled in recent weeks, the broader global fixed-income landscape continues to cap the downside in U.S. yields, making it difficult for the 10-year to sustainably trade below the 4% threshold. In other words, this is not an outright bond-bearish environment, but it is one that has constrained the scope for a more meaningful rally.

Technically, this dynamic has manifested itself in the 10-year yield consolidating into a tightening triangular formation, with lower highs pressing down against a firm floor near 4%. Volatility has compressed, signaling that the market is increasingly coiled for a directional move, even if conviction on timing remains limited. Importantly, this consolidation reflects not just uncertainty around Fed policy, but also a balance between domestic disinflationary forces and persistent global term-premium pressures.

While the baseline case still favors range-bound trading, the risk of an upside resolution cannot be ignored. A break higher in yields would likely be driven less by U.S. inflation re-acceleration and more by external or structural forces—including renewed upward pressure from global sovereign markets, the AI capital expenditure, increased Treasury supply absorption challenges, or a resurgence in term premium as liquidity conditions tighten. In that sense, any upside move in yields would look less like a growth scare and more like a plumbing-driven repricing, consistent with a world where global borrowing costs remain structurally higher.